The Other Side of SAIL's Profits

7/29/2019 The Other Side of SAIL's Profits

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The other side of SAILs profitsISHIKAA SHARMA AND UMASHANKARS.* 5TH NOVEMBER2012

State-owned steel giants profits are found increasingly because of raw material subsidies and not due to realeconomic value addition. This only leads to wastage and poor operational management, causing higherpollution

The public sector steel giant Steel Authority of India Limited (SAIL) frequently boasts of itsgargantuan profits and the Maharatna tag to brush away all criticism on its poor environmental

performance levels. By claiming its immense contribution to the nation, SAIL feels they should beconsidered above board on pollution issues. But a deeper analysis on value added from its latest financialstatements shows a degree of misrepresentation to its shareholders and the nation.

The analysis done by Centre for Science and Environment (CSE), a Delhi research institution, finds thatthe profit earned by SAIL is increasingly because of the free iron ore gift provided by the government, orin other words, by the citizens of the country.

As per a detailed CSE study, post independence in 1950s, the Indian steel sector was brought under thelicensing system and large integrated steel plants (above 1 million tonne capacity) were reserved only forthe public sector under SAIL. To get the different factories kick started, swathes of iron ore mines weregiven away free (see Table 1) along with making provisions for their rail linkages and other freebies such

as water, land, etc.

Table 1: Iron ore freebies

SAIL Plant Mines allotted Year of Commissioning

Bhilai Steel Plant Dalli, Rajhara (both Chhattisgarh) 1960

Durgapur Steel Plant Bolani (Orissa) 1960

Rourkela Steel plant Barsua (Orissa) 1960

Kalta (Orissa) 1966

Kiriburu (Jharkhand) 1964

Meghahatuburu (Jharkhand) 1985

Bokaro Kiriburu(Jharkhand) 1964Meghahatuburu (Jharkhand) 1985

Source: Raw Materials Division, Steel Authority of India Limited1

COMMENTARY

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*Green Rating Project, Centre for Science and Environment, New Delhi

1 Source: http://www.sail.co.in/pnu.php?tag=others_unit_raw_material (as viewed on November 5, 2012)


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Steel price and market distribution was also stipulated by the government and hence profits of thecompanies remained under control. In 1991, when the government liberalised the Indian economy, steelsector was also freed2. No license was henceforth required for setting steel units. However, as

government feared cheaper steel imports could harm the Indian producers, it still kept import duty highat above 90%3. The import duties were then gradually brought down to 25% by 20034. From August 2004onwards, owing to heightened inflation worries, government sharply reduced duty of steel to 5% to bringit in line with the global pricing5.

Import parity pricing

Interestingly though, at this very juncture, i.e. from 2002 onwards, the world steel market had changed. AsChina began ramping up its infrastructure and shifted to urbanisation, it gobbled all iron ore among otherraw materials, leading to its price rise (see graph 1). Simultaneously, there was spurt in demand for cars andhouses in the western countries fuelled by cheap credit. These factors led to rise in international steel prices.

All this while, though SAIL continued to get benefit from free iron ore, it began to sell steel at domestic market

prices, which in turn closely tracked the international prices plus the import duties. For example, ifinternational price of a particular grade of steel was 700 USD/ tonne, SAIL would sell the same grade to itsIndian customers at 735 USD/tonne (considering 5% import duty) or around Rs. 36750/tonne. The pricing ofproduct at close to import parity prices6 boosted its profits sharply (see graph 1).

Graph 1: SAIL operating profit from 1990s tracks international iron ore price

Source: Iron ore - China Import price IndexMundi.com, Operating profits - SAIL Annual Reports for the corresponding years

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GREEN RATING PROJECT

2 Source: Joint Plant Committee, Ministry of Steel http://www.jpcindiansteel.nic.in/frame2.asp and http://www.jpcindiansteel.

nic.in/profile.asp (as viewed on November 5, 2012)

3 Source: Report of the Working Group on Steel Industry for the Eleventh Five-Year Plan (2007-2012) Annexure 4,

http://planningcommission.nic.in/aboutus/committee/wrkgrp11/wg11_steel.pdf (as viewed on November 5, 2012)

4 Source: Report of the Working Group on Steel Industry for the Eleventh Five-Year Plan (2007-2012), Annexure 4,

http://planningcommission.nic.in/aboutus/committee/wrkgrp11/wg11_steel.pdf (as viewed on November 5, 2012)

5 Source: Budget, Ministry of Finance, 2004-05 http://indiabudget.nic.in/es2004-05/chapt2005/chap56.pdf (as viewed on

November 5, 2012)

6 Source: http://www.moneycontrol.com/news/brokerage-recos-sector-report/jpc-data-shows-weaknesssteel-consumption-

nirmal-bang_768165.html (as viewed on November 5, 2012)

200

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0

14,000

12,000

10,000

8,000

6,000

4,000

2,000

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SAILopera

tingpro

fit

,Rscrore

Aug-8

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Aug-8

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Aug-8

8

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0

Aug-9

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Aug-9

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Aug-9

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Aug-0

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Aug-0

6

Aug-0

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Aug-1

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Ironorepr

ice,U

SD/tonne

International

iron ore price

SAIL operating profit

Iron ore price movement and SAIL operating profit trend


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Extent of profits

CSE found the extent of benefit gained from differential price of iron ore (i.e. market price of ore minuscost of iron ore incurred by SAIL) was a whopping 70 percent of its operating profit in the recent years(see Table 2 below).

Table 2: Cheap iron ore now bringing in the moolah

Parameter Units 2006-07 2007-08 2008-09 2009-10 2010-11 2011-12

Value of Iron ore consumed Rs. Crores 1488.31 1725.38 1791.95 1844.36 2337.79 2666.96

Volume consumed Million tonnes 24.65 25.44 23.28 23.24 23.07 22.00

Iron ore mined cost for SAIL Rs./ tonne 603.7 678.1 769.7 793.5 1013.3 1212.3

Average market price of Rs./ tonne 1629.9 2024.6 2855.7 2583.1 4287.7 4104.2

iron ore for the year (for

NMDC ore)*

Average market price of Rs./ tonne 1466.1 1822.1 2570.2 2324.8 3859.0 3693.8

iron ore assuming 10%

lower value of SAIL ore due

to slightly poor quality

compared to NMDC

Difference between Rs./ tonne 862.4 1144.0 1800.5 1531.2 2845.6 2481.6

market price and SAIL

cost for iron ore

Differential value in iron Rs. Crores 2126.1 2910.8 4191.8 3558.9 6564.8 5459.4

ore costing due to

captive mines

Operating profit stated Rs. Crores 10966 12955 10946 11871 9030 7658

Share of differential iron Percentage 19% 22% 38% 30% 73% 71.3%

ore value as operating

profit

Net profit Rs. Crores 6202 7537 6170 6754 4905 3543

Ratio of differential Percentage 34% 39% 68% 53% 134% 154%

value of iron ore as net

profit

Source: Analysis from SAIL Annual Reports and financial statements, Centre for Science and Environment, Delhi*Source: NMDC ore price as per letter dated 25 Jan 2012 by Chief Minister, Orissa to Union Minister of Mines, http://www.orissaminerals.gov.in/Download/DO-CM-reg-mineral-resource-rent-tax.pdf (as viewed on November 5, 2012)

In other words, had the government just sold iron ore in the open market (like it does through other stateowned firm NMDC Limited), it would have earned revenue of say Rs. 5459 crores in 2011-12, which isequivalent to almost 70 percent of SAILs operating profit for that year. And this needs to be comparedwith SAILs annual dividend (payout) to government of only Rs. 700 crore in 2011-12.

In the earlier decades till 1980s, the iron ore gift never translated into windfall gains as governmentcontrolled the market price of steel. So, the noticeable difference of this benefit is only visible in therecent years, due to reasons mentioned above. In essence, this implies that SAILs profit over the recentyears is increasingly because of the citizens gift of free iron ore and not because of its own internal valueaddition.

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COMMENTARY


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Opportunity costs not accounted

In economics, this concept of substitute value is called as opportunity cost. It is defined as value of a

foregone activity when another alternative is chosen (see box below for details). Opportunity costs arehidden monetary value and do not appear in the balance sheet of a company. So in this case, theopportunity cost for the government had it sold iron ore in the open market has increased from 19% ofSAILs operating profit in 2006-07 to an astounding 70% in 2011-12.

In finance too, the concept is called as earnings before interest tax depreciation and amortisation(EBITDA) due to conversion, or simply Conversion EBITDA. This concept is normally used by financialanalysts and investment banks such as Standard Chartered7 to measure whether a company is reallyadding value, over and above any subsidies, such as free raw materials, it receives. The ConversionEBITDA of SAIL was just USD 21 (or Rs. 1050)/ tonne steel in 2011-12 as against USD 100-150/ tonne steelfor international producers such as POSCO Korea who do not own captive iron ore and coal mines. Even

the other public sector Vizag Steel, which does not own any iron ore or coal mines, exhibits healthyConversion EBITDA of USD 87-100/ tonne steel in the last two years (see graph 2).

Graph 2: Conversion EBITDA unravels many hidden truths

Source: CSE analysis, Note: Vizag Steel 2011-12 figure based on advanced estimates

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Opportunity costs: This cost involves trade-offs between two options by weighing costs andbenefits. Opportunity costs are not the amount one actually transacts and hence are not costs inthe traditional accounting sense. But they should be given due consideration in decision making.The term opportunity cost is normally used in natural resource economics to weigh financialoption of say, mining in a forest land vs revenue generated from the forest. Nevertheless, they arevital in managerial decision making, in particular for resource planning and distribution.

For example: If a person has to chose between task A that earns him Rs. 100 and another task Bof free leisure activity, then the opportunity cost of the leisure activity is Rs. 100 and not zero asper the traditional accounting sense.

7 Source: Standard Chartered Equity Research, 25 November 2010

http://www.myiris.in/shares/research/SCR/STEAUTIA_20101125.pdf (as viewed on November 5, 2012)

300

250

200

150

100

50

0

2006-07 2007-08 2008-09 2009-10 2010-11 2011-2012

SAIL

Vizag Steel

POSCO Korea

240

200

Conversion EBITDA USD/tonne steel

240

260

160

127

9087

100

159

225

151

129141

94

24

21

118


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Maharatna tag - a misnomer

Given these facts and accounting insights, even the Maharatna tag of SAIL needs to be questioned. The

tag granted by the Government of India through its Department of Public Enterprises (DPE) is for stateowned entities with certain eligibility criteria, and allows greater financial and operational autonomy indecision making. Among other criteria, a company should meet average annual net profit of over Rs 5000crores during the last three years8 for being granted the tag.

So with SAILs profit being artificially inflated by free government (read citizens) subsidy of iron ore onone hand and by import parity pricing of its products on the other, it is able to meet the annual net profitcriterion. Thus, the company should owe the Maharatna tag to its citizens and not because of theoperational efficiency of its management.

In fact, with its current state of affairs and even with all these freebies, it may lose its Maharatna status ifit continues to underperform in FY 2012-13 as the average net profit for three years is expected to slipbelow Rs. 5000 crore (see Table 2 above).

Meanwhile, for the new proposed mining bill, the union ministry of steel claims it wants reservation ofiron ore mines for state owned entities, pleading largely public interest and claiming the entities aremodeled on sustainable and holistic development.

Overall, it is found that the government through its citizens is increasingly grandfathering SAIL. This onlyleads to extravagance by the company management, wasteful expenditure, frequent breakdown ofequipments, wastage of raw materials and resources and poor supervision (see box below). All theseeventually manifest in higher plant level resource use and pollution. If opportunity cost is taken intoaccount, the citizens of the country are taking care of the companys management and employees, anunfortunate situation in a liberalised economy.

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COMMENTARY

8 Source: Department of Public Enterprises guidelines 19th May 2010

http://dpe.nic.in/sites/upload_files/dpe/files/glch0931.pdf (as viewed on November 5, 2012)

Iron ore mine in Orissa

AGNIMIRHBASU


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How could this be remedied?

In the short term, starting from this financial year (2012-13), all concerned public or private sectorcompanies which receive subsidies from the nation, should report Conversion EBITDA along with pastfive year performance, as per CSE recommendation. This will make all stakeholders aware of whether thesubsidies are really being used for the welfare of the citizens, or only for the welfare of handful of owners,management and employees. The DPE also needs to overhaul its Maharatna eligibility criteriaconsidering Conversion EBITDA.

Secondly, over a period of time, non-renewable natural resources should never be awarded free to anypublic or private sector enterprise. It is important to break them down to different business entities (likethat in power sector where coal mining, power generation, transmission and distribution are separated)to bring in efficiencies of free market pricing.

Ignorant of these apparent fallacies, the Indian government continued to freely handover SAIL theRowghat mines in 2009. Its time the government, planning commission and citizens wake-up to the otherside of SAILs profits so as to bring about not only economic but also environmental benefits.

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EQUIPMENT HEALTH AFFECTS PRODUCTION

1) News: Production at SAILs Bhilai Steel Plant dipsRaipur, April 11, 2012: Production at the public sector Bhilai Steel Plant dipped in the 2011-12fiscal from the previous financial year, the management said, blaming the aging coke ovenbatteries for the fall.

The health of some aging coke oven batteries posed a big challenge from early on in the year,affecting coke production and gas availability for the reheating furnaces of the mills, it said in astatement.

The flagship unit of Steel Authority of India Ltd (SAIL) located in Durg district, some 30 km west ofChhattisgarh capital Raipur, produced 5.13 million tonnes (MT) of hot metal, 4.90 MT of crudesteel and 4.29 MT of saleable steel in the just ended financial year.

The plant had in fiscal 2010-11 had posted a record production of 5.71 MT of hot metal, 5.33 MTcrude steel and 4.57 MT of saleable steel. It was expected that the plant would further consolidateits production in year 2011-12 but the production dipped.

Source: http://www.sarkaritel.com/production-at-sails-bhilai-steel-plant-dips (as viewed on November 5, 2012)

2) SAIL crude steel production dips in 2011-12CSE note: Even while the domestic steel market is growing, SAILs crude steel production dipped3.6% year over year (yoy) in 2011-12. Profit margins are also falling. A major reason was thefaltering coke oven batteries, among many other reasons.

Statement from the 2011-12 Annual Report of SAIL, page 9: Lower availability of Coke Ovens at

Bhilai Steel Plant, Durgapur Steel Plant and Bokaro Steel plant and resultant Coke Oven gasshortage, however, affected production during the year adversely.

Source: http://www.sail.co.in/pdf/areport-2011-12.pdf (as viewed on November 5, 2012)

The Other Side of SAIL's Profits

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